INTEREST RATES, RECESSION OR DEPRESSION?

Reproduced with kind permission from Aubie Baltin.
Whilst we have high regard for the author's analysis
we do not necessarily agree with all conclusions/projections made.
Readers are urged to conduct their own research.

The right man in the right place at the right time

Before
we can even begin to discuss interest rates intelligently, we must
first define what it is that we are actually talking about, since it
appears that all the talking Media Heads and Wall Street analysts
don’t seem to understand what interest rates are or how they
work: The constant barrage of economists parading across our TV
screens don’t seem to know what interest rate’s primary
functions are, so how can they know whether to raise them or not?

WHAT ARE INTEREST RATES?

#1
Interest rate is just another word for price. It is the price to
borrow money and its price is supposed to be determined exactly the
same way as the price of any other commodity, product or service is -
through the interaction of supply and demand.

#2
However, unlike every other product, commodity or service, interest
rates and money do not operate in a Free Market. Interest rates and
the supply of money are manipulated (controlled) by the Fed. They do
this by controlling the amount (supply) of money that is available in
the banking system through their Open Market Operations (buying &
selling treasury bonds in the open market) and by changing their
deposits that they hold with their individual member banks, directly
affecting their reserves and thus their ability to lend. They also
increase the money supply the good old fashioned way, by printing it.

WHAT ARE THE FUNCTIONS OF INTEREST RATES?

#1
Interest rates determine the propensity of people to either save or
consume: When interest rates are manipulated (by the Fed), it
influences the degree that people are willing to defer present
consumption, i.e. save. If interest rates are manipulated too low,
like they are now, people are no longer willing to save. When the
interest rate becomes negative (the interest rate is lower than the
inflation rate) people, since they are now being paid to go into
debt, take on excessive debt as well as excessive risk because that
is exactly what they are being paid to do. Conversely, when interest
rates are high, such as in the early 80’s, people were willing
to forego current consumption in order to avail themselves of the
ultra high interest rates and we ended up having high saving rates.

#2
When interest rates are high, the demand for cash is extremely
low. People can’t wait to deposit every cent that they can
spare so as to earn that high rate of interest. However when rates
are low, the propensity to hold cash is very high because at a 1% or
2% interest there is not much to be forgone by keeping extra cash in
your pockets.

#3
The Velocity of money (how many times the money supply turns over
during the year) and therefore the calculation of the money supply
itself is greatly affected by the level of interest rates. When rates
are outside the normal range, the FED cannot calculate the velocity
until long after the fact and thus they lose track of what the money
supply really is and its effect on the economy, leading to the
interest rate conundrum.

#4
Interest rates also determine which investments should or should
not be made, according to the investment’s expected rates of
return. When interest rates are manipulated too low, a great many
investments and risks are undertaken that should not have been,
because these poor investments will fail at the first signs of
weakness in the economy or be forced into bankruptcy with the
eventual return to rising interest rates. This is the main underlying
cause behind the business cycle. The imbalances (wasted resources) in
the economy must be liquidated before the economy can stabilize
enough so that the misused scarce resources become available for the
next growth phase.

#5
A neutral rate of interest is the rate that neither stimulates nor
restricts the economy. Greenspan was and Bernanke is in a conundrum
as to what that rate is or should be. Previously, that rate was
thought to be 1.5% to 3% over the inflation rate. (According to the
latest CPI report (5%) the Discount Rate should be at least 6.5%.) In
the past, when the Fed did not manipulate the rates except at the
extremes, the market was able to determine what that rate should be
through the interactions of the Free Market. But today with US
savings nearly zero and the CPI and interest rates being highly
manipulated, the Fed is unable to measure the Velocity of Money and
with negative interest rates, the Fed does not have a clue as what
the neutral rate should be.

#6
The Discount Rate is the rate that the Fed charges Banks who need
to borrow money from the Fed to meet their reserve requirements. The
FED was originally created to be “the Lender of Last Resort”,
avoiding bank runs and liquidity squeezes. The Discount Rate charged
used to be a Punitive Rate; a rate that was somewhat above the Fed
Funds Rates (the rate at which Banks lend to each other in order to
meet their overnight reserve requirements). But today, the discount
rate is above the Fed Funds rate, drastically lowering the banks’
cost of money and reducing the amount of interest they are willing to
pay for deposits: so that now massive amounts of money are being
borrowed from the FED without having to worry about the excess demand
increasing interest rates, greatly increasing the banks’
ability to create money out of thin air: Completely negating the
supply/demand function in setting interest rates. This break down in
the function of a free market has led to the creation of “The
Carry Trade.” In so doing, the Fed has completely lost control
over the banks and near banks’ (FNM, FRE, GE, GMAC etc.)
ability to create money and have therefore lost control over the
money supply. This has led directly to the creation of the Stock and
Bond Market Bubbles as well as to the Real Estate Bubble that has,
after 15 years, most probably topped out and is in the process of
rolling over into a crash.

For
a long time now, regardless of the ever increasing demand for loans
and the seventeen ¼% Discount Rate increases, Long Term rates,
because of the ongoing Carry trades, refuse to go up and reflect the
true conditions of the market.

THE FED’S CONUNDRUM

Fed
Chairman Bernanke like Greenspan before him once again raised the
conundrum of the divergence between short term and long term rates.
At the end of Jan 07, the yield on the 10-year Treasury-Note stood at
4.4% still below the 4.6% rate in June of 2004, the year when the Fed
funds rate was only 1%. Bernanke like Greenspan before him blames
some mysterious 'pressures' for the divergence between the Federal
funds rate and long-term rates. However careful examination shows
that there is no mystery. The so called mysterious pressure is in
fact the natural outcome of the BOJ and the Fed's own easy money
policies.

When
it comes to the economy, what matters most is the availability of
money and not the purported interest rate stance of the Fed. For
example, in order to maintain a given interest rate target in the
midst of a strong economy, the Fed is forced to push more and more
money into the system to prevent the Fed funds rate from rising above
its targeted rate. This in turn causes long term rates to fall. The
opposite will happen should the economy go through a period of
weakness. Since they are always behind the curve, they end up
exacerbating the problem rather than dampening the fluctuations.
Since June 2004, despite raising the Fed-funds rate from 1% to 5 ¼%,
the Fed has actually hiked the pace of pumping money into the system,
creating a negative yield curve. In short, the Fed has been talking
tough while acting like a very loose $5 street walker.

TIME LAGS:

Nobody seems to realize that there are always time lags
whenever there are any changes in FED or Government policy, whether
they be Taxes, Money Supply or even High Oil prices or ??? . It
takes time for the Free Market to send its signals through to every
participant and it then takes time for every participant to react.
The estimated average time lag between changes in the Fed Funds
policies and the growth momentum of industrial production is on
average 12 to 36 months. Hence, at the same time as the FED’S
attempted tighter stance (beginning June 2004), the effect of the
previous and continuing loose money stance was still in force and
continuing its influence for the following 30 months. So in spite of
their regular ¼ % increases, the yearly rate of growth of
industrial production stayed strong into 2007. However the strong
economic activity made possible by its loose money policy, had made
the FED Funds rate targets unsustainable—so the Fed had to
continue to increase the money supply to prevent the Fed Funds rate
from overshooting their stated targets. This monetary pumping has
thus far prevented the growth momentum of the economy from slowing,
also preventing any meaningful rise in long-term interest rates.

INFLATION:

According to Milton Friedman, inflation is at all times a monetary
phenomenon. If you keep printing money (beginning in 1994) at a rate
that is 10% a year above the economy’s real rate of growth,
inflation must eventually ensue and it has. It first showed up in the
stock market, then found its way into the Bond market and eventually
into Real Estate. Now that the world economy is awash in Fiat cash,
it’s finally finding its way into commodities, takeovers and
corporate buyouts. Now with nothing much left to inflate, the money
is finally finding its way into the CPI. Witness the price explosion
of Gold and Silver: Even though the government has thus far managed
to convince everyone (through their ingenious manipulation of the
CPI) that there was and is no inflation, Nevertheless, inflation has
already begun to rear its ugly face and it won’t be much longer
before we see just how high inflation really is. Bernanke, to his
credit, is now looking to the future while the rest of our esteemed
talking heads are still focusing on their rear view mirror.

CONCLUSION

THE RIGHT MAN IN THE RIGHT PLACE AT THE RIGHT TIME

In my opinion, Bernanke is possibly
the only man at the Fed who realizes that he has no other choice but
to push interest rates even higher than most would now even dream of
in order to try and head off an explosion in inflation: Even if it’s
in the face of the economy’s growth momentum starting to trend
down. Like it or not and despite what Wall Street and the politicians
want, he knows that the economy cannot continue growing above trend
for any more sizeable length of time without going into rampant
inflation. He realizes that both the USA’s and the world’s
economies are now more out of balance and are in the biggest bubble
mode than in 1929 or any other time in world history. He realizes (at
least I hope he does) that our only HOPE is to engineer a recession,
hopefully it will only be a mild one, so as to avoid a combined
Stock, Bond, Real Estate and Take-over CRASH, which would lead to a
world wide depression.

He and only a few other people in the
world realize that cutting interest rates now, especially in the face
of tightening lending standards, would not only do nothing to save
the real estate market, but would actually bring on the depression by
causing the US Dollar to tank. A crashing dollar would set the
world’s financial system on it ear; the results of which would
be devastating. He knows full well the lag effect of the last 18
months of interest rate policies will eventually end up setting in
motion a depressing effect on economic activity which will begin to
take effect, more than likely, within the next 1 to 3 months if it
has not already done so. Let us hope that the FED, because of the lag
effect will NOT, as they always have in the past, doesn’t
overshoot their targets and exacerbate the problem that they
themselves have created.

In the meantime, the lag effect of the
higher interest rate policies since June 2004 will eventually finding
its way into rising long term rates, undermining the stock, bond and
real estate markets that sprang up on the back of Greenspan’s
FED ultra loose monetary policy, setting in motion a much needed
controlled economic slowdown instead of a Bust, giving the economy a
chance to self correct its huge imbalances.

Greenspan realized full well that the
bigger the boom the bigger the inevitable bust: His main objective
was to push the time of the inevitable crash into the next Chairman’s
term and thus preserve his legacy. To give him his due, he was also
trying to raise interest rates high enough before Bernanke finally
took over so that the FED would then have some ammunition to
hopefully slow down the crash and keep it in only a Recession mode.:
However “IT” will be, when “IT” comes, at
first similar to 2001, too little and too late. In 2001, we were
sitting on projected massive budget surpluses and unified government
so Bush was able to get massive tax cuts passed and succeeded in
stopping the recession in its tracts; but this time around the US is
not only in a “Guns and Butter Economy” but with both
massive trade and budget deficits instead. With the Democrats now in
control of Congress, there will be NO new tax cuts coming to save the
day and stop the Crash. A looming and even bigger danger is that we
may actually face tax increases and a return to job destroying NEW
DEAL policies which are even now being bandied about in Congress.

Let us pray that I’m right and
Bernanke is not only smart but lucky as well, he is our only chance
to prevent a major financial catastrophe.

GOLD and SILVER

The Gold and Silver Bugs, after
serving a 25 year prison sentence mired in a Bear Market, have been
finally let loose: But they are still talking about fundamentals:
They have been always right about the shortages of new supply vs.
demand, but that didn’t stop the Bear Market. For the past few
years, the supply demand imbalances have become so acute that we are
now in a world wide Bull Market for all commodities not just for Gold
and Silver. But that is not from where an exploding Bull Market in
Gold and Silver comes from. In order to get a 1978-1980 type
explosion in Gold and Silver (and their stocks) prices, you require
the combined emotions of both GREED & FEAR. So far we have been
only experiencing the beginnings of the Greed phase. I know this
because even the biggest and best of the Gold Bugs keep calling for
periodic corrections. When Greed really takes over, there is no
longer talk of correction as prices begin to jump 5% to 10% in one
day and people line up to buy bullion as signs pop up everywhere “WE
buy and sell gold”. That final stage only begins as the FEAR
of a collapsing currency embroils men’s guts. Once both fear
and greed take over the market and the short squeezes begin in
earnest, there is no way of predicting how high the high. $2200 Gold
and $200 Silver seems to me to be the barest minimum targets, maybe
$5000 or even $10,000 could be in the cards, Your guess is as good as
mine. I realize that the great majority of you may think I’m
crazy, but when you yourself start thinking that these numbers might
actually be too low, then and only then, will we be firmly in the
clutches of the blind Greed and Fear phase that will mark the final
top.

Who are these people that will end up
buying at the top? Why they are the same ones that got in near the
lows but sold out for what turned out to be relatively small profits
and were waiting for that one more pull back that never came (it
came, it was 36% but it only lasted two weeks) to get back in. Be
careful and make sure that I am not describing YOU. Remember a Bull
Market will always do whatever it has to do to make the majority of
the people wrong.

WOULDA SHOULDA COULDA

We are now in or close to the end of
that correction in Gold and Silver that everyone was dreaming of. In
my opinion not only is that correction over, but we are about to
complete Wave 2 of the explosive Wave 3. So now that its here, how
many of you are actually buying and or fully invested? Not very many
since most of you have now lost your nerve. You are about to learn
what a real Bull Market in Gold looks like when this market, which is
about to enter Wave 3 of 3, finally explodes and starts to go up so
fast you won’t have a chance to get back in.

Just in case you haven’t
noticed, the resumption of the Bear Market in the overall stock
market that I have been warning you about since October 06 is right
on schedule to completing its top. Perhaps it will take one more
breakout to a new high to set that final and biggest BULL TRAP in
history.

What To DO Now?

Liquidate all your short term Debt.
Build up your cash position by selling most of your stock and long
term bonds into any further rally. Buy Gold and Silver NOW. Use your
buying power if you have no cash to increase your gold and silver
stock positions. But whatever you do, get back in now or you will be
sucked back in right near the eventual top.

The
above information has been gleaned from information that I believe to
be reliable but is not guaranteed by me. The information provided is
strictly for educational purposes only and is not meant to be used as
investment advice or recommendations.

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